H-P may be stuck with limited options

Commentary: Some analysts want break-up, but debt may get in way

SAN FRANCISCO (MarketWatch) — More investors seem to be coming around to the idea that Hewlett-Packard Co. should break itself up, but the company’s slumping businesses and high debt load could make that option challenging — to say the least.

HP

H-P CEO Meg Whitman is leading a long-term turnaround effort at the tech giant.

The most recent breakup chatter started earlier this month, right after H-P’s
HPQ, -1.74%
analyst meeting.

Last week, days before even more depressing data about the PC industry was released, the idea of H-P breaking up got some new credence. Steven Milunovich, an analyst with UBS, even invoked the names of its revered founders, Bill Hewlett and Dave Packard, in his plea.

“We are more convinced than ever there is value at H-P and that its full realization requires a break up of the Silicon Valley icon,” Milunovich wrote in a note to clients last Monday. “We think Bill and Dave would agree.”

There are even a few on the Street who think private equity firms might also try to persuade H-P to go private, since these are the type of investors who look for troubled assets with big potential.

But the problem is that H-P’s long-term debt has ballooned to nearly $25 billion, an amount that could hamper both of these potential scenarios.

“I think they’re kind of stuck,” said Eric Jackson, founder and managing member of Ironfire Capital LLC, who does not currently own any H-P shares, in an email. Jackson noted that with “so much debt,” he doesn’t think H-P could go private.

“Breaking up would be good for focus, but I don’t think they could get much for PCs and printers,” he said.

Milunovich of UBS believes that H-P should separate PCs and printers from corporate computing, services and software, because its full value won’t be realized by improving the company’s operations, which is the current focus of H-P Chief Executive Meg Whitman.

It’s not the first time investors have called for H-P to break apart. Even during the Carly Fiorina era, when the merger with Compaq was slow to bear fruit, some began to call for spinning off the PC business.

In August of last year, during the ill-fated rein of Leo Apotheker, break-up talk started again. In one of several moves that would lead to his demise, Apotheker led the company to issue a statement, saying that the H-P board was evaluating its options for the PC business. Read more about Wall Street's reaction to H-P’s news in 2011.

As my colleague John Shinal recently pointed out, Wall Street “reacted in horror” to the idea, and it was seen as one of several errors by Apotheker that helped him loose his job. Wall Street and some pundits bemoaned H-P’s potential loss of purchasing power if it separated PCs. When Whitman took over, she moved to stabilize the company and investors by deciding to keep PCs, and then merged printers into the PC business. Read “H-P missed the boat, Whitman can't change that.”

Milunovich acknowledges that argument in his thesis. “Sure, H-P would likely lose some purchasing power if it breaks up, but the gain of focus, branding and optimization more than offset lost synergies, in our view,” he wrote.

“The current lack of independence seems to be an albatross — in many ways, H-P is only as good as its weakest business. Currently, the problems in services are dragging the entire company down from both a business and customer perception standpoint,” he added.

But now, even if it wanted to, it could be too late for the company to split. The PC business, at least according to Gartner, just lost its top spot. And printing is also under siege, as more people are reading and sharing on their devices and printing far less. Read more about the latest third-quarter PC data.

“I think they did try to sell it and they didn’t get the price they wanted,” said Shaw Wu, an analyst with Sterne Agee, in an interview. “Now that they have waited another year, it’s probably worth less. H-P is no longer the No. 1 player. Tablets have an even stronger foothold and now there are questions around printing.”

H-P’s debt pile is another major factor that may limit its options. In the fiscal second quarter ended April 30, 2008, prior to the company’s acquisition of EDS, H-P’s long term debt was $7.7 billion By July 31, 2011, the debt load had ballooned to $19 billion, in large part due to the needs of operating a huge tech services business, which typically requires high up-front costs.

As of H-P’s last report, for the period ended July 31, long-term debt was $24 billion. Analysts said the large jump over the prior year was fueled both by EDS and the $10.3 billion acquisition of Autonomy last October.

H-P’s corporate credit rating is now a “BBB+,” according to Standard & Poor’s, which downgraded the company from an “A” rating last November. It placed the company on its Credit Watch list last year after the Autonomy acquisition, but removed it from that list a few months later.

A lower debt rating makes it harder for companies to borrow. If H-P were to split up, the debt burden could mar whichever business it would be allocated to, or raise questions on how to divide it up. The debt would also probably deter any private equity firms who might want to think about taking H-P private.

H-P, for its part, told analysts that it is focused on rebuilding its balance sheet, as part of its current restructuring.

“If you really care about the balance sheet, do something aggressive,” said Zhiping Zhao, an analyst with CreditSights Inc. She said H-P needs to rethink its commitment to paying its full dividend and its share buybacks.

But even if H-P is quietly considering all options again, it probably is, as Jackson noted, “stuck.”

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